Gold Prices Actually RISE After Interest Rates are Hiked

Gold Prices Actually RISE After Interest Rates are Hiked

After rallying 26% in 2013 and 12% in 2014, the S&P 500 has gone nowhere this year. It gained just 0.6% in the first two quarters of 2015.

Thomas Lee, the Head of Research at Fundstrat Global Advisors, found that this is extremely rare.

Lee found that the US stock market almost never “goes nowhere” two quarters in a row. The last time it happened was in 1904.

Following those two “go nowhere” quarters in 1904, the Dow Jones Industrial Average (an index of 30 large US stocks) had a huge rally. It gained 43% in the next six months.

Big moves, up or down, can often happen after a market goes nowhere for a long time. It’s why a famous trading quote says, “Never short a boring market.”

We don’t expect a huge 1904-like rally anytime soon. But a sizable move, up or down, wouldn’t surprise us after the stock market breaks out of its current trading range.

This chart shows how the S&P 500’s 87% rally since October 2011 is stalled for now:

• While the S&P 500 is flat this year, the Nasdaq is up 10.3%…

But there are signs that the Nasdaq’s rally isn’t as strong as it looks.

The Nasdaq is an index heavy on tech stocks. Last week, The Wall Street Journal wrote about the “lack of participation” in the Nasdaq’s rally:

More than half of the index’s gain this year is due to three stocks that also happen to be among the largest by market capitalization: Apple Inc., Google Inc. and Amazon Inc.,according to Mike O’Rourke, chief market strategist at JonesTrading.

Throw in biotechnology company Gilead Sciences Inc., Facebook Inc. and Netflix Inc., and the figure rises to 80%.

Six large stocks account for 80% of the Nasdaq’s gains this year. Generally, it’s not ideal for a few big stocks to drag an index higher. It’s healthier when a lot of stocks contribute to a rally.

• This is part of the stock market’s “bad breadth” problem…

Market “breadth” refers to the number of stocks participating in a bull or bear market. Professional investors use it to measure a market’s health.

On Tuesday, 27 stocks on the New York Stock Exchange (NYSE) hit one-year highs. But 164 stocks hit one-year lows. In a healthy market, more stocks set new highs than new lows.

This isn’t good news… but it doesn’t mean you should panic and sell all your stocks. The market has had “bad breadth” several times in the last few years, but it was a false alarm every time. After all, we’re still in a bull market. As we mentioned, the S&P 500 has now gained 87% since October 2011. And it hasn’t “corrected” by 10% or more in 46 months.

Our friends at Daily Wealth Trader explained yesterday that “bad breadth is reason for caution… but not a ‘sell everything’ panic. The big picture in stocks is still up.”

• This afternoon, the Federal Reserve announced that it won’t raise interest rates yet…

While economists in a Bloomberg survey saw virtually no chance of an interest-rate rise this week, investors will scrutinize the statement for any hint that policy makers are inclined to move in September. The odds of an increase at that meeting were put at 50 percent, according to the survey.

If the Fed does raise rates in September, it will be for the first time since 2006.

Conventional wisdom says that rising rates are bad for gold prices. The argument goes that gold doesn’t generate income. So when interest rates rise, people prefer to own bonds and dividend-paying stocks instead of gold.

But it turns out that’s dead wrong. The price of gold actually goes up when the Fed raises rates.

History shows that gold prices also fall leading into a rate hike and generally rise, though sometimes with a lag, after the first rate hike… Investors are apt to unload gold in anticipation of tightening monetary policies. This negative pressure is sustained until the Fed announces a rate hike, which then eases the negative sentiment towards the yellow-metal. This explains the subsequent rallies in gold that occurred shortly after the Fed announced the first rate hike in the last four tightening cycles.

This is an important finding. Most investors assume that higher rates will hurt gold prices. But the data shows that rate hikes have actually been good for gold prices in the recent past.

We borrowed this chart from HSBC to show what happened the last time the Fed began a rate hike cycle in 2004. As the Fed raised rates (represented by the red line), gold prices went up (black line):

Chart of the Day

Last week we told you about the bloodbath in commodities like oil, lumber, and coffee. As a group, commodities are at their lowest level since 2002. They’re even cheaper than they were during the financial crisis.

The chart below shows a simple ratio between the Bloomberg Commodity Index and the S&P 500. The Bloomberg Commodity Index tracks 22 different commodities.

The higher the ratio, the cheaper commodities are compared to stocks. And as you can see, the commodity/stock ratio is at an all-time high right now.

This shows that commodities are the cheapest they’ve ever been compared to US stocks.